The reason foreclosures will continue

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A YEAR ago, 49 states and the federal government brought five of the country’s biggest banks to heel. They crafted a nationwide foreclosure settlement that ended a series of abuses, and committed the banks to keeping struggling homeowners off the streets. The settlement is working. But as it takes hold, it’s exposing a huge rift in the housing market. The government’s own mortgage arms, Fannie Mae and Freddie Mac, still won’t meet the same standards the big banks have committed to, and until they do, foreclosures will continue to drag on.

Prior to last year’s settlement, the nation’s biggest banks greeted the foreclosure crisis with indifference. They paid lip service to the notion of helping troubled homeowners, but let homeowner assistance languish while they rushed foreclosures through the system. They signed legal papers they hadn’t read, and they seized homes they didn’t legally own. They treated their own rights as lenders as sacrosanct, but trampled on consumers.

For all this, the banks paid dearly. Last February, Bank of America, Citigroup, JP Morgan, Wells Fargo, and GMAC agreed to the largest consumer financial protection settlement in US history. The $25 billion national mortgage settlement allowed for some cash payments to states and foreclosed homeowners. Banks reserved the bulk of the settlement’s billions, however, for homeowners still struggling with the housing bust.

The banks’ cash penalty funded a foreclosure prevention effort in Attorney General Martha Coakley’s office that has assisted 4,600 borrowers and stopped 427 foreclosure auctions. In addition, a November report by the national settlement monitor showed the five big banks completing 4,000 foreclosure relief cases in Massachusetts, with another 2,100 in their pipelines. The five banks have written down 2,000 homeowners’ outstanding principal balances by a total of $125 million. They’ve written off $2.5 billion in principal nationally.

Last year’s nationwide settlement got the country’s biggest banks to accept an argument housing advocates had been making for years — that the banks’ interests in minimizing their foreclosure losses and struggling borrowers’ interests in remaining in their homes were often aligned. Foreclosures often cost banks more money than loan modifications, and loan modifications don’t create homeless families or broken neighborhoods.

The settlement forced banks to atone for years of conducting improper foreclosures by working to keep current borrowers in their homes, but Bank of America, Citigroup, JP Morgan, Wells Fargo, and GMAC can only reach so far. Roughly half of the housing market falls in the hands of Fannie Mae and Freddie Mac, the bailed-out, federally owned mortgage giants. The state and federal foreclosure settlement imposed an aggressive set of rules on the country’s biggest banks, but Fannie and Freddie have set up an entirely different set of rules for themselves.

Banks avoid foreclosures and keep troubled homeowners in their homes by knocking down borrowers’ monthly mortgage payments. They can do this by rolling loans into lower interest rates, or by adding years to a mortgage’s life. The most direct way, though, is to chop the amount owed on a loan down to market value. Reducing mortgage principal acknowledges market realities and stabilizes hard-hit neighborhoods, since foreclosures have been concentrated in areas that have suffered the steepest home price declines. It’s also good business. All things being equal, borrowers who see their principal reduced are less likely to re-default on their loans than are borrowers who just get lower interest rates or longer-lived mortgages.

Principal write-downs work, but Fannie and Freddie have dodged them because they’re politically poisonous. So even as one branch of the government has forced the country’s biggest banks to use principal reduction as a tool for keeping homeowners out of foreclosure, the two mortgage companies that taxpayers own, Fannie and Freddie, won’t join in. The companies would rather foreclose than write down principal for troubled borrowers. They’re refusing to sell foreclosed homes to nonprofits that sell foreclosed homes back to their former owners — a post-foreclosure tool for reducing principal — even in the face of a Massachusetts law banning such restrictions.

These are decisions grounded in fearful politics, not policy. But their impact is widespread. Fannie and Freddie hold over 2,600 foreclosed homes. They’re wrestling with another 19,000 seriously delinquent mortgages. Every one of those loans represents a family in need. Not all have the income to repay even a modified home loan. The ones that do, however, deserve the strongest possible shots at holding on to their homes. That means having the government’s own mortgage companies meet the same standards the government extracted from Wall Street.

Paul McMorrow is an associate editor at CommonWealth Magazine. His column appears regularly in the Globe.

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